Simply amazing. Junk bond indexes and funds should now drop the “High Yield” description that they use in their names. With these bonds now yielding around 5% we have sold out of most of our positions in this area. At this level the returns are just not worth the risk. That doesn’t mean junk bonds will blow up any time soon but we would rather sell high and take what the market is giving us at this time. Junk yields at 5% are a direct consequence of the Fed’s Zero Interest Rate Policy as investors fight for anything with yield. It wasn’t too long ago when you could get 5% on a money market!
To view the entire article please visit: barrons.com
Here is an exerpt from the article:
The 5% yield barrier has proved no match for this Federal Reserve-fueled junk-bond market, which last night reached yet another all-time record-low average yield-to-worst of 4.97%, according to the Barclays US High Yield Index. It marked a new level of market capitulation to central-bank forces as it’s the first time the index has dipped below 5% in its 30-year history (before January the market had never even fallen below 6%). The average price of 107.31 cents on the dollar also marks a record high.
The other widely followed market index, the Bank of America Merrill Lynch High Yield Master II Index, closed last night within a whisker of 5%, at 5.005%, with the average dollar price closing above the 107-cent mark for the first time ever at 107.20.
“The most surprising thing this shows is that there’s really no yield floor for this market,” says Brad Rogoff, head of credit strategy at Barclays. “Those mental barriers really haven’t existed that we thought existed maybe a year ago.”
With the Fed and central banks around the world keeping interest rates near zero and pumping money into the financial system, investors have been encouraged, if not forced, to invest in the highest-yielding investments around, even if those yields aren’t that high anymore. All this liquidity and low borrowing costs have helped companies shore up their balance sheets, and default rates remain negligible, which further emboldens investors to take on credit risk.
Rogoff says the high-yield market’s main attraction used to be – as its name would indicate – its high yields. At sub-5% average yields now, the market’s main justification is its comparative yield versus other types of bonds, namely its risk premium over Treasuries. The option-adjusted spread on the Barclays index stands at 406 basis points over Treasuries, below its historic average but still far wider than the historic tight of 233 bps reached on May 23, 2007. The spread of the Bank of America index stands at 424 bps, above its all-time low of 240, also recorded in May 2007.
“Usually this is a market that’s traded based on yield, but now it feels like it’s trading based on spread. It’s much tougher to justify based on historical yield standards but on spread, its reasonable,” Rogoff says. The average spread could still tighten a bit more, he adds, but any further tightening “is not necessarily in conjunction with where rates are now,” meaning Treasury rates would have to rise before junk bond spreads compressed much further, leaving all-in junk-bond yields more or less where they are now.
The average dollar price of 107 cents presents another problem, since many junk bonds can be called by their issuer beyond a certain date at 103 cents on the dollar. Rogoff says roughly half of the market is currently trading above its first call price. “Those call dates typically are not tomorrow, but the market is definitely constrained,” he says. “A year ago, you would have thought there was a yield floor created by a dollar price constraint.”.......
To view the rest of the article, please visit: barrons.com
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